Magazine article Mortgage Banking

S & P: Troubling Trends Shadow Bright CMBS Market

Magazine article Mortgage Banking

S & P: Troubling Trends Shadow Bright CMBS Market

Article excerpt

Barring a major increase in interest rates or an unforeseen shock to the capital markets, expect U.S. commercial mortgage-backed securities (CMBS) issuance volume to remain stable this year, according to a report by New York-based Standard & Poor's Ratings Services (S & P).

According to the report, Some Troubling Trends Shadow a Bright U.S. CMBS Market, in addition to historically strong performance, the U.S. CMBS market has positive momentum and an encouraging outlook in terms of delinquencies, investor demand and liquidity. However, several trends in CMBS and commercial real estate (CRE) collateralized debt obligation (CDO) transactions remain a concern to S & P because they may result in higher risks to investors, noted the S & P report.

Some of the troubling trends S & P noted include: deteriorating underwriting and origination standards for commercial mortgage loans; relaxed requirements for capital expenditures, tenant improvement and leasing commission reserves; an increasing number of loans that are either interest-only for their entire terms or have some periods of interest-only before amortization begins; loans with debt service coverage (DSC) below 1.0x that lack adequate upfront interest reserves; loans secured by esoteric collateral; and construction loans.

Furthermore, a changing CMBS landscape--characterized by increased liquidity, fierce competition among loan originators, an influx of new buyers and a CDO-focused/short-term mindset--has significantly altered the market's supply/demand dynamics, possibly making transactions more vulnerable to negative credit events, noted Kim Diamond, managing director in Standard & Poor's Global Real Estate Finance Group.

"While these trends were more exceptions to the rules in the past, they have now become standard practice," said Diamond.

The vast majority of loans included in today's transactions are interest-only for a portion of the loan term or for the entire loan term, thus greatly increasing balloon balance refinancing risk, particularly if interest rates rise and property values are not sustained, said Diamond.

The relatively attractive yield on real property as compared with alternative investments during the past few years has resulted in significant amounts of capital flowing into real estate and a potential overinflation of property values, according to the S & P report. …

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